To reduce its balance sheet, the Fed has rolled down assets, allowing them to mature. By choosing to not reinvest the principal from these matured assets, they reduce the size of the balance sheet. My understanding is that the reinvestment occurs in longer dated securities, which would put flattening pressure on the curve. Estimates indicate a reduction of these purchases would raise 10y yields 40-60bps [0]. All other things being equal, this would lead to steepening of the yield curve.

> I'd be leery of any predictions of recession in the US based solely on yield inversion.

Not all yield curve inversions have preceded recessions, but almost all recent recessions have been preceded by yield curve inversions. Yield curve inversions lasting 10 days or longer tend to have more predictive power. The inversion in March did not last that long, for example. On average, a recession follows 14 months after an inversion [1].

[0] https://www.ft.com/content/828169e8-8902-3d5a-903d-586bf22cc...

[1] https://www.advisorperspectives.com/articles/2019/04/01/a-hi...

https://fred.stlouisfed.org/graph/?g=o4ro

Of course maybe this time is different...

When the value of the spread between a long dated (e.g. 10Y) and a short dated (e.g. 3m) instrument increases, the yield curve is referred to as 'steepening'. When this spread decreases (even when becoming more negative), the curve is said to 'flatten'.

  / steep
  - flat
  \ even flatter

How has that affected expectations and behaviors?

I'm aware. Markets are forward looking. As you can see, yields have dropped precipitously since the announcement, and the curve has flattened. This is consistent with expectations of increased purchases of securities in the tail end of the curve.

That's my point :-)

It's been a reliable signal in the past, but perhaps this time is different.

Interestingly, some economists postulate that such an inversion may be somewhat causative of recession, due to increased short term funding costs relative to long term funding costs.

Yes, we're in agreement :-)

> Interestingly, some economists postulate that such an inversion may be somewhat causative of recession...

That could be true... I don't know.

Then in a recession, the Fed reduces rates to heat it up.

Historically, interest rates drop 5 percentage points in recessions.

But since rates are currently just north of 2 percent, there's no room to maneuver. If a recession hits now, the Fed cannot drop rates 5 percentage points. They'll run out of ammunition at the zero lower bound.

QE showed that the Fed has more options than lowering interest rates.

There's no reason rates cannot go negative. Bund yields (Germany) are negative currently [0]. As a matter of policy, there are other approaches that may be taken. A modified Taylor rule with a zero lower bound may deliver optimal policy if the neutral rate falls below zero [1].

[0] https://www.bloomberg.com/markets/rates-bonds/government-bon...

[1] https://www.albany.edu/~bd892/Papers/TaylorRule.pdf